The House of Lords Reverse the Law on Security Over the Book Debts - August 2005

National Westminster Plc v Spectrum Plus Ltd & others

The House of Lords reverse the law on security over the book debts

As many of you may have seen, the House of Lords have now returned their judgement on the Spectrum matter. As I raised in my earlier note to you, the House of Lords have taken a fairly robust position and have overturned the earlier Siebe Gorman decision on which many banks and lenders have relied upon in the past 25-30 years.

The House of Lords has gone so far as to actually state that Siebe Gorman was wrongly decided and have accepted the Crown’s appeal that the Bank’s security over book debts only took effect as a floating charge, despite the fact that Spectrum had been required to pay the proceeds of the book debts into an overdrawn account with the Bank. Their reasoning was very much influenced by the fact that Spectrum, as the chargor, could still use the proceeds of the collected debts and the only way they could see a fixed charge could be created over those debts was if the proceeds had to be paid into a blocked account. All arguments put forward about whether or not the bank account was in credit or debit were viewed as largely irrelevant, as their Lordships focussed heavily on the lack of restrictions on the use of those funds by the company itself.

In addition to this volte face, the House of Lords were clear in rejecting a further argument put forward by the Bank’s legal counsel that the impact of reversing the law and allowing this decision to apply to existing security would be so detrimental that the equitable way forward was to apply the change prospectively; that is to security created from now. The Lordships rejected this out of hand. They could see no good reason for postponing the effect of overruling Siebe Gorman and went so far as to dismiss the argument that the Bank’s lending decisions were influenced by the belief that a fixed charge over book debts would be enforceable. Their Lordships declared themselves highly sceptical of this approach, saying that banks were in the business to receive and hold money for their customers and to lend on that money to others who wanted to borrow. Their view was that the effect of a fixed charge over book debts was a single issue amongst many as to why a bank would lend money to a company and should not be assumed to be such a major issue of influence on that decision. Equally, it was also noted that any decision to apply Siebe Gorman prospectively would deny preferential claimants the priority which they were entitled to, on the basis of the decision reached by the House of Lords in this matter.

So where does this leave the law on securities?

On the positive side of matters it has meant that insolvency practitioners now have clear guidance on their application of book debts, in terms of priorities. This will hopefully free up a number of insolvencies which have been held up, awaiting the outcome of this decision.

The bad news is that the judgement provides little or no practical guidance on how lenders construct their security agreements to give themselves an effective fixed charge over book debts. Many commentators have raised this as a major failing of the judgment but an alternative view may be that the judgment has made it clear that no matter how much clever drafting is applied, the very nature of book debts means that they do not lend themselves to a fixed charge. This is a considerable leap from the Siebe Gorman position but, whilst it may be an unpalatable truth, could be seen as the clarity that has been missing in this area of law for a long time. Many have viewed Siebe Gorman as trying to “fit” the law to a suitable outcome and the decision has subsequently been questioned on numerous occasions.

It would seem, therefore, that the obvious outcome for lenders is that there will need to be a general review of security options open to them rather than trying desperately to hold on to the concept of fixed charges over book debts. This seems a more sensible strategy compared to trying to unravel the requirements of the ‘blocked account’ that was put forward by the House of Lords as the only arrangement appropriate to applying a fixed charge over book debts. Given, however, that no guidance is given on the level of intervention and control that would need to be applied to such an account, it would be difficult to see how a lender could successfully use this mechanism without risking the dangers of shadow directorship. It goes without saying that other institutional or even private lenders, who will not have such control over bank accounts, will find little or no comfort from this judgement.

Ultimately, however, one suspects that the only way to successfully deal with this is to reflect these changes in the future terms and pricing on which any lender may be prepared to lend to its customers and clients.

There may be interesting times ahead.


KATIE ASHWORTH
FOLLETT STOCK
AUGUST 2005


Katie Ashworth is an associate solicitor in the commercial team of Follett Stock. She specialises in company and corporate work including both business and share sales and purchases, MBO/MBI, joint venture and investment, shareholders matters, equity funding and corporate governance. She also advises directors and shareholders on their rights and obligations.

Katie can be contacted by email at katie.ashworth@follettstock.co.uk or by telephone on 01872 247283.